KEY DATA: Orders: -0.6%; Excluding Aircraft: -0.5%; Capital Spending: -0.2%/ Pending Sales: -0.5%; Over-Year: -2.2%

IN A NUTSHELL: “The manufacturing sector is still growing, but maybe at a less robust pace.”

WHAT IT MEANS: One of the highlights of the current expansion has been the rebound in manufacturing. Well, that upturn may be moderating. Durable goods orders fell in May, marking the second consecutive monthly drop. Declines were pretty much across the board as the vehicle, civilian aircraft, computer, electronic equipment and metal sectors all were off. Demand for machinery, communications equipment and defense aircraft did increase. Still, backlogs rose sharply, indicating that production will continue to be strong for quite some time. Slowing vehicle sales and building inventory is not good news for the auto sectors. Finally, capital spending also slowed a touch. While the tax cuts provided the means of invest, firms have not done so consistently as spending has been up and down like a yo-yo this year.

The National Association of Realtors reported that pending home sales were off in May. Weakness in the South, the biggest region, offset gains in the other three regions. Housing’s big problem is not demand, as prices are up sharply. It is a lack of inventory that is restraining sales and that is likely to continue to be an issue for quite a while.  

MARKETS AND FED POLICY IMPLICATIONS: The housing sector is being buffeted by a lack of homes on the market, rising interest rates and soaring prices. That combination does not make for a stable market. The recent moderation in rates should help, but if growth is as strong as most economists expect, inflation and longer-term interest rates should continue to filter upward over the course of the year. And the Fed has made it clear that short-term rates will be rising as well. So, don’t expect this sector to lead the way. In addition, the rising costs to manufacturers from tariffs is just starting to bite and while initially, those costs might be absorbed, there is only so much some of the businesses can stand. We could see them raising prices as long as those tariffs are maintained. As for U.S. firms facing tariffs put on American made products, those impacts are also in the beginning stages. Thus, while the economic fundamentals are strong, some cracks are beginning to appear. Ultimately, investors will have to decide how much of the threats are real and how much bluster. They cannot keep getting whipsawed. Until then, volatility is likely to continue.  

KEY DATA: Starts: +5%; Year-to-Date: +11%; 1-Family: +3.9%; Permits: -4.6%; Year-to-Date: +8%; 1-Family: -2.2%

IN A NUTSHELL: “The rebound in home construction means the sector might actually add to growth this quarter.”

WHAT IT MEANS: Home construction had been lagging this quarter, which was a bit of a surprise. And with mortgage rates rising, there was concern the sector could falter. Instead, housing starts rose solidly in May. But the data were all over the place. For example, construction in the Midwest surged by over 60%. Multi-family building activity nearly doubled and single-family starts jumped 45%. Those changes came after large declines in April. We are talking huge changes that are usually seen in the winter, not the spring. Meanwhile, starts were down in the other three regions, with the Northeast posting a double-digit decline. So we need to step back and see what happens in June before we make any major conclusions about the strength of the home construction sector. Looking forward, permit requests moderated, but they had been running well above the pace of construction and it was inevitable there would be a pull back. A massive increase in the Northeast and a more moderate decline in the Midwest were more than offset by weakness in the West and especially the South. For the last three months, permit requests ran higher than starts, so there is a reasonable expectation that the large jump in construction will be sustained, at least for a couple of months.

MARKETS AND FED POLICY IMPLICATIONS: Second quarter growth looks like it was solid and the remaining question is how big a number will print. Estimates range up to 4% or even more and that cannot be ruled out. I am more in the 3.5% range (actually, a touch below that), but there is still a lot of data to come that could change that. The strong housing number could push up GDP estimates. Regardless, the economy is in good shape, which just about everyone understands. Broad based growth would support the Fed’s expected four moves this year while not spooking investors too much. It is hard to argue that the economy will falter from a fairly modest one-half percentage point increase in short-term rates if the economy is expanding robustly. Indeed, if or when the current trade war fears fade, investors will get back to watching economic variables and those look good.

KEY DATA: Phila. Fed (Manufacturing): +11.2 points; Orders: +22.2; Prices: +6.6 points/ LEI: +0.4% / Claims: +11,000

IN A NUTSHELL: “While the strong growth should continue through the rest of the year, the rising pricing power it is supporting is becoming worrisome.”

WHAT IT MEANS: The concerns about strong growth and expansionary fiscal policy being implemented at the wrong time are that inflation and interest rates could surge. So, what firms have been doing when faced with rising demand and increasing costs? One indication comes from the May Philadelphia Federal Reserve’s Business Outlook Survey. Today’s report was for manufacturers and boy was it strong. Manufacturing activity in the Middle Atlantic region jumped in early May, led by a surge in new orders. Firms are not only adding more workers to meet the growing demand but are working their current employees longer. But the real story is in the pricing data. The prices received index hit its highest level in over 29 years. You have to go back to the early ‘80s to find any period where the current level was sustained. Already, 55% of the respondents say they have been raising their prices and almost two-thirds believe they will be able to so over the next six months. In addition, firms are expecting their price increases to be in the 3% range over the next year. That has to worry the Fed members.

Looking forward, the economy should be strong for months to come. The Conference Board’s Leading Economic Index rose solidly again in April. Only two of the ten components, stock prices and housing permits, were down and stocks have done pretty well so far this month. So this index should continue to point to strong economic activity.

On the labor front, jobless claims jumped last week, but the level remains ridiculously low. Of course, I keep saying we are in a labor shortage environment, and I keep believing that, but the proof for workers is in wages and they still are not rising as fast as the claims data would imply.

MARKETS AND FED POLICY IMPLICATIONS: Right now, the trends in inflation and interest rates are not good. Oil prices continue to rise and hit levels not seen since November 2014. Until it is clear what will happen with Iranian exports, oil prices should remain elevated. I would not be surprised if prices back down, but I think we will wind up with higher oil costs as a result of backing out of the Iranian agreement. Unless that decision is modified, the Fed has to assume the higher prices, at least to some extent, are sustainable. That should be a factor in not just the speed of interest rate hikes but also in how fast the Fed will shrink its balance sheet. Meanwhile, rising oil prices and surging bond rates (the 10-year T-Note hit its highest rate in seven years) seem to mean little to investors. I guess they will worry about the future when it comes. But the Fed will not close its eyes to what is going on and a rate hike at the end of the June 12-13 FOMC meeting looks highly likely.

KEY DATA: Imports: +0.3%; Over-Year: +3.3%; Nonfuel: +0.2%; Exports: +0.6%; Farm: -1.2%

IN A NUTSHELL: “The import price pressures that had been building seem to moderating.”

WHAT IT MEANS: While economists can debate all they want about the lack of wage gains, ultimately what matters is the rate of consumer inflation. Wage increases supported by productivity gains have limited inflationary implications. But retail price increases don’t have to come from just a rise in labor expenses. We get a significant portion of our consumer and producer goods from other nations and that means we have to watch the import price numbers carefully. During the second half of last year, import goods inflation was soaring. So far this year, import price inflation has moderated, as can be seen in the April report. We know that energy prices are rising. However, nonfuel cost increases are not as threatening. They were up moderately in April. Food prices were down, capital good costs were flat and consumer goods import prices rose modestly. Just about all the gain came from the industrial supply sector and it wasn’t all petroleum. In addition to petroleum-based products the cost of other industrial inputs such as wood and minerals were also up sharply. On the export side, firms were raising prices in just about every sector except farm products. Agricultural exports are extremely exposed to a backlash from the administration’s trade policies and that may explain, at least in part, the large decline. Between April 2015 and April 2016, farm export prices were up 4.6%. Over the past year, they rose only 1.4%. In April, the only export products that didn’t show large price declines were related to fish/seafood.

An early May reading on consumer confidence came out today. The University of Michigan’s Consumer Sentiment Index was flat during the first half of the month. Expectations rose but respondents thought that current conditions were not as strong as they had been.

MARKETS AND FED POLICY IMPLICATIONS: The more moderate increases in import prices are nice to see. The rise in foreign product costs have been strong enough to convince the Fed to continue tightening but not so high that the members need to worry that inflation will suddenly soar. That is, inflation is running neither too hot nor too cold. It is running just right for rate hikes every other meeting and that is what most economists, including myself, expect. Investors seem to be growing comfortable with that pattern of rate increases and they should be. A solidly growing economy and a move back to more normal interest rates are indications that the negative impacts of the Great Recession are finally disappearing. Now we can start focusing on the next set of problems, which already be cropping up. As Jamie Dimon noted, there’s a 100% chance of another economic downturn. Of course there is. But the issues are when and what will cause it. Recessions are created by either bubbles bursting and/or policy mistakes. Potential bubbles are stocks and interest rates, while the policy mistakes could fiscal policy at the wrong time, too much Fed tightening and/or trade risks. Together, though, they do add up to a formidable list of potential issues that could derail the economy, maybe not in the next twelve to eighteen months, but not much after that.

KEY DATA: CPI: +0.2%; Ex-Food and Energy: +0.1%/ Real Hourly Earnings: 0%; Over-Year: +0.2%/ Claims: unchanged

IN A NUTSHELL: “Inflation may not be soaring, but it is high enough to  wipe out most of the gains workers are seeing in their paychecks.”

WHAT IT MEANS: Solid economic growth and tight labor markets have yet to translate into rapidly accelerating inflation. The Consumer Price Index rose moderately in April and excluding food and energy, it increased only modestly. The details, though, were all over the place. There were strong increases in gasoline and fuel oil prices, but electricity and piped gas costs fell. Food price gains picked up steam, though cookies and ice cream costs were off sharply – thankfully. Interestingly, medical care costs were tame, with medical commodity prices actually down. Over the year, both medical commodity and services costs rose less than the overall price index, a real surprise. I thought medical costs were soaring. Oh, well, another misconception put to rest. And then there are used vehicle prices, which dropped sharply. The record sales in 2015 and 2016 are having an impact as the two and three year old vehicles coming off leases are flooding the market. That helped restrain the rise in the overall index. Since people don’t usually buy vehicles frequently, I am not sure if the sharp decline in used vehicle prices matters a whole lot to the average worker. But the cost of housing does and that keeps rising sharply.

Even though inflation did not jump in April, neither did wages. So, when you adjust the rise in hourly earnings by the increase in consumer prices, you find that household spending power went nowhere. Worse, over the year, consumer costs were up by 2.4% and hourly earnings by 2.6%, so real earnings rose a pathetic 0.2%. As I say month after month, it is hard to sustain strong growth if consumers don’t have the income to spend and that is the case.

 That wages are not increasing is a conundrum that defies explanation. Jobless claims, when adjusted for the labor force, remained at record lows last week. In addition, job openings are at record highs and the number of positions available is about the same as the number of people unemployed. No matter what measure you use, even the really stupid unemployment rate, you know, the one that adjusts for people saying their frustrated or they want a full-time job but cannot find one (for whatever reason), it is clear that labor markets are tight.

MARKETS AND FED POLICY IMPLICATIONS: Today’s data raise questions that investors may not be asking. Specifically, how can companies that are linked to the consumer make money when incomes are rising minimally? The savings rate is extremely low and the recent rise seems to indicate that households are either saving the tax cuts or paying down debt. Thus, if we are to maintain a growth rate close to 3%, businesses will have to start investing the tax cuts they received. Will they do that? It makes sense to improve efficiencies by upgrading machinery and equipment, but many the large, publicly traded companies appear more intent on raising dividends, increasing stock buybacks and/or bidding for other companies. The merger and acquisition phase seems to be just getting started. So, yes, we could see 3% growth this year, but it will be hard to sustain. And if we get it, how will firms keep wages and prices down in that strong growth economy? That is the real question.

KEY DATA: PPI (Final Demand): +0.1%; Ex-Food and Energy: +0.2%; Goods: 0%; Services: +0.1%

IN A NUTSHELL: “Despite the modest increase in wholesale costs, the inexorable rise in inflation remains inexorable.”

WHAT IT MEANS: Inflation pressures are building; there is little doubt about that. What is unclear is how much will price increases accelerate. Costs had been rising fairly sharply at the wholesale level, but that was not the case in April. A large decline in food prices coupled with a modest gain in energy helped limit the rise in producer prices to the smallest increase since December. There was minimal pricing pressure on both goods and services and even excluding the more volatile food and energy, costs rose only moderately. Over the year, the gains in both the headline and core indices decelerated, but remained in the 2.5% range, so we cannot say that inflation pressures have disappeared. Looking at the details, there were few outliers. Prices of vegetables and eggs fell sharply, a major factor in the large drop in food. Otherwise, most of the individual categories posted modest to moderate declines or increases, the majority being declines.

Looking into the future, the April report is not likely to become the norm. Intermediate level producer costs rose sharply for food, energy and core (non-food and energy) measures. That was the case at the crude product level, though food costs were down. Basically, there is building pressure in the pipeline.

MARKETS AND FED POLICY IMPLICATIONS: The inflation pressures we see in all the consumer indices are real. With oil prices above $70/barrel and the ending of the Iran agreement likely to keep prices up, it is hard to see how inflation will moderate anytime soon. The Fed looks at the headline number now, so energy matters. I have made the argument to anyone who will listen that over time, it is the entirety of retail price increases that matter to households. The headline increases in the Consumer Price Index (CPI) and Personal Consumption Expenditure deflator (PCE) have been persistently above the core increases and that is what consumers pay. The Fed has moved back toward the top line number, which makes sense. Thus, there is every good reason for the FOMC to continue to normalize both rates and the Fed’s balance sheet. Quantitative tightening will continue and is scheduled to accelerate. Rate hikes are not likely to stop unless there is a major crisis. Investors need to factor that into their thinking. Of course, with all the political issues swirling around Washington, lots of fundamental economic considerations are being pushed to the sidelines.

KEY DATA: ADP: +204,000; Construction: +27,000/ HWOL: -69,300

IN A NUTSHELL: “Businesses are hiring solidly and they are looking for even more workers.””

WHAT IT MEANS: The latest Fed meeting will end soon but before we get the statement, there are some data to discuss. Since they have to do with one of the Fed’s major concerns, the labor market, it is likely they will be a part of the discussion. Since this is the week of Employment Friday, Wednesday is when we get a snapshot of what private sector hiring may have been. According to ADP, firms were out adding workers at a very solid, if not strong pace in April. The gains were spread fairly evenly across the different sizes of firms, though companies with 50 to 499 workers were the most active. Looking at the specific industries, the need for construction workers remains robust, while health care employees are also in strong demand. The only sector where jobs declined was information services.

The number of want ads posted online faded in April. The Conference Board’s Help Wanted OnLine Index fell, but it has been bouncing around quite a bit lately. That said, the level of want ads is still high enough that we should see solid hiring going forward. There were declines in every region, though the greatest weakness was the Northeast, New York in particular. As for occupations, the demand for computer and mathematics experts continues to soar, while sales people are no longer needed as much. That makes sense since the Internet is not a person-to-person sales vehicle.

MARKETS AND FED POLICY IMPLICATIONS: While the labor market data are important, today is all about the FOMC meeting and the statement that is to be released. The best guess is that the Fed will leave rates alone. Actually, it would be a surprise if anything else were done. The continued strength in hiring has to provide support for the members’ belief that they can continue to raise interest rates without materially affecting the economy. So what we need to watch is the statement and how strong a signal it sends that the next tightening is coming. Most economists, including myself, expect a rate hike at the June 12-13 meeting. If Friday’s jobs report is solid and wage gains continue to accelerate, anything but a hike then would be a shock. In June, we also get the Fed members’ forecasts, which could point to four rather than three increases this year and I think an increase in what may be the terminal rate for this cycle. That would point to four increases, next year as well, which is where I stand.

KEY DATA: Disposable Income: +0.3%; Wages: +0.2%; Consumption: +0. 4%; Prices (Over-Year): +2.0%; Excluding Food and Energy (Over-Year): +1.9%/ Pending Sales: +0.4%

IN A NUTSHELL: “Inflation is at the Fed’s target level and it is likely the 2% rate will remain in the rear view mirror for quite some time.”

WHAT IT MEANS: With the battle between interest rates and earnings raging on, the crucial economic numbers are those that tell us about inflation pressures. Today, we saw that the Fed’s preferred measure of consumer costs, the Personal Consumption Expenditure price index may have been flat between February and March, but it rose by 2% over the year. Energy costs are up since March and the Chicago Purchasing Managers report that their prices paid neared a seven-year high in April. We could have a big increase in the April index. Even excluding food and energy, prices are also rising pretty much at the Fed’s target pace.

How much inflation accelerates depends upon the willingness and ability of consumers and businesses to spend. We have yet to see the capital investment boom, but that may come in the second half of the year. As for households, the key is income growth and the March report didn’t tell me that there was a huge increase in spending power. Personal income may have been up solidly, but wages and salaries rose more modestly. Income gains are being bolstered by large increases in dividends.   Most middle and lower income households who receive dividends tend to get them in their retirement accounts, so it doesn’t get spent. And there is only so much that upper-income households spend out of increased income. That is why consumption, which rose solidly in March, is not likely to soar this year.

The National Association of Realtors reported that pending home sales improved modestly in March. Weakness in the Northeast and to a lessor extent in the West offset decent gains in the South and Midwest. Over the year, contract signing activity is down, further indicating that the housing market is not accelerating. Indeed, with mortgage rates rising, don’t expect housing to lead the way going forward.

MARKETS AND FED POLICY IMPLICATIONS: Last year, former Fed Chair Yellen argued that the deceleration in inflation was due to temporary factors. Indeed, inflation had accelerated for two years, reaching 2.2% in February 2017 before easing back. Well, Dr. Yellen was correct in her analysis and we are nearing the high hit last year. Indeed, don’t be surprised if the overall index exceeds that peak when the April or May numbers are released. And don’t be shocked if the rate continues to slowly accelerate. So, if you are still holding onto the belief that the Fed will move only three times this year, you might want to reconsider that stance. That said, I don’t expect inflation to spike. In part, that is due to the continued limited gains in wages and salaries that will restrain consumption. And with mortgage rates likely to continue rising, housing is not likely to pick up much steam. Thus, growth is not likely to accelerate significantly, unless businesses actually start investing really heavily in capital goods. So, investors are now facing a conundrum. Interest rates are likely to continue to rise through the rest of this year and into next. Meanwhile, growth should be solid but probably not robust. Will non-tax-driven earnings be able to sustain strong increases? That is a good, and critical, question.

KEY DATA: GDP: 2.3%; Consumption: +1.1%; Consumer Prices (Quarterly): +2.7%; Over-Year: +1.8%/ ECI (Over-Year): +2.7%; Wages: +2.7%/ Sentiment: -2.6 points

IN A NUTSHELL: “The acceleration in growth from the tax cuts has yet to kick in, but it does look like inflation is rising.”

WHAT IT MEANS: Tax cuts and government spending increases should lead to better overall economic activity, but that was not the case in the first quarter of the year. The economy expanded at a moderate pace that was well below the 2.9% rate posted in the fourth quarter of last year or the 3.3% rate in the third quarter. Solid business investment and a narrowing trade deficit were offset somewhat by soft consumer and government spending. Additions to inventory added to growth and that may be a sign that firms expect conditions to improve going forward. But for me, the story in this report was not the economy: It was inflation. Consumer prices rose sharply in the first quarter and even if you take out food and energy, the increase was still very high. Even though the gain from a year ago has yet to hit the Fed’s target of 2%, another quarter of high price increases similar to that posted in the first quarter will get us there.

Adding to my concern about inflation was the report on first quarter employment costs. The increase over the year was the highest in nearly a decade for both the overall index and for wages and salaries. Of real concern is that the private sector costs are growing faster than the public sector, which means that firms are facing even greater accelerating labor cost pressures.

Consumers were a little less optimistic in April than they had been. The University of Michigan’s Consumer Sentiment Index faded, led by a sharp decline in the perceptions of current conditions. Expectations remained solid, though they have stopped rising. The report indicated that the level of the index was consistent with a 2.7% increase in consumption over the next year. Given the tax cuts, that would be disappointing.

MARKETS AND FED POLICY IMPLICATIONS: Growth decelerated for the second consecutive quarter, not usually a sign of an economy picking up steam. But it was unreasonable to expect the impacts of the tax cuts to show up immediately. Businesses will invest more, though it is not clear how much more, and household spending will improve. But the decelerating growth pattern and the softening in optimism creates doubts about the ability of the economy to post the large gains many used to defend the passage of such a large tax cut. That said, there are questions about the first quarter seasonal adjustments, as the growth rates tend to be the lowest of the year. This was just the initial estimate, which will likely change. So don’t give up hope just yet. If as expected, growth does accelerate from the first quarter moderation, it is likely that inflation will follow suit. By the end of the current quarter, consumer price gains, using almost any index, will likely hit or exceed the Fed’s 2% target. Accelerating inflation would support rate hikes for the rest of the year and sustain the upward trend in market interest rates. No good economy goes unpunished and higher wage and price inflation and increasing interest rates are likely to be with us for quite a while. The earnings vs. interest rate battle is on.

KEY DATA: Orders: +2.6%; Excluding Aircraft: +0.1%; Capital Goods: -0.1%/ Claims: -24,000

IN A NUTSHELL: “The surge in capital spending that was supposed to be triggered by the tax cuts has yet to be seen, but it is still early.”

WHAT IT MEANS: Remember how the business tax cuts were supposed to induce massive increases in business investment? Well, that has not happened yet. Durable goods orders rose solidly in March, but chalk that gain up to a surge in civilian aircraft orders. Excluding aircraft, demand for big-ticket items was largely flat. Sharp declines in orders for machinery and computers offset increases in demand for metals and communications equipment. Vehicle orders were up minimally. The most closely watched number in this report is nondefense capital goods orders excluding aircraft and after a solid rise in February, orders fell slightly in March. Even more troubling was that this measure was lower in the first quarter than in the fourth quarter of 2017. It was expected to rise if only because firms were cautious at the end of last year as they waited for the tax bill to actually be passed.

Jobless claims cratered last week to the lowest level since December 1969. To put the number in perspective, the labor force back then was half the sixe it is now. Adjusting for the size of the labor force, we are at record low levels. Put simply, labor markets are extremely tight.

MARKETS AND FED POLICY IMPLICATIONS: It is too early to use one my favorite phrases, “never mind”, when it comes to the impact of the tax cuts on business investment. Just because taxes were reduced and incentives were added to foster more capital spending doesn’t mean businesses were ever going to rush out and invest right away. There may be some off the shelf projects that were green lighted, but in general, spending on major projects is not a quick or easy decision. I have argued that second half growth would show accelerating capital spending and I am sticking to that forecast. That said, it is a little disconcerting to see so little new spending plans announced, especially given all the announcements about stock buy-backs, dividend increases and merger and acquisition attempts. Tomorrow, the initial (called advance) estimate of first quarter growth will be released. Consensus is around 2% and nothing released this week is likely to change most forecasts, including mine, which is 2.6%. Whatever we get could be the low point for the year. But how much faster we grow will depend upon the willingness of businesses to put the tax-induced higher earnings to work for things other than stock price increases. As for consumers, there are no clear signs they are spending like crazy either. The labor markets are drum-tight, but wage gains are still less than needed to cause overall economic growth to surge, especially given the steady rise in inflation. Firms seem to be willing to lengthen delivery times rather than increase wages to attract new workers. At least that is what I frequently hear as I tour the country. Tomorrow’s Employment Cost Index may show signs things are changing. On the investor side, the battle between higher earnings and higher rates continues. But the earnings season will end soon while the rise in rates is likely to continue through the rest of this year and probably next. Can you say “choppy”?